chapter 12: Current Liabilities and Employer Obligations

contingent liabilities

Liabilities that are not definite and absolute, but instead give rise to potential liabilities

another name for accrued liability

accrued expense

collection for a third party

sales tax

typical current liabilities

-accounts payable -notes payable -The Current Portion of Long-term Debt -accrued liabilities(aka expenses) -prepayments by customers -collections from third parties -Obligations to be Refinanced

vacation pay

Accounting rules provide that companies expense (debit) and provide a liability (credit) for such accumulated costs when specified conditions are present. Those conditions are that the accumulated bene t (1) relates to services already rendered, (2) is a right that vests or accumulates, (3) is probable to be paid to the employee, and (4) can be reasonably estimated.

liability

Amounts withheld from employees' paychecks are recorded on the employer's books

Landry paid $5,000 cash for warranty service work. If a Warranty Liability account had been previously established, the proper journal entry to record the service work would be

Debit Warranty Liability for 5,000, and Credit Cash for 5,000

net pay

Gross earnings less all applicable deductions

understate income for the year

If the journal entry to record an accrued liability were accidentally recorded twice

Contingent liabilities should be recorded in the accounts when

It is probable that the future event will occur The amount of the liability can be reasonably estimated.

NOT a typical current liability?

Prepayments (advances) to suppliers

w-2

Shortly after the conclusion of a calendar year, an employer must review its employee records and prepare a summary wage and tax statement

contingent liabilities

Some events may eventually give rise to a liability, but the timing and amount is not presently sure. Such uncertain or potential obligations are known. THESE ARE NOT TO BE CONFUSED WITH GENERAL BUSINESS RISKS (environmental contamination, product warranties, legal disputes)

rule of 78

Some loan agreements stipulate that prepayments will be based on this tricky technique. A year has 12 months, and 12 + 11 + 10 + 9 + . . . + 1 = 78; somehow giving rise to the "rule of 78s.

A common scenario would involve the borrowing of money in exchange for the issuance of a promissory note payable

The amount borrowed is recorded by debiting Cash and crediting Notes Payable When the note is repaid, the di erence between the carrying amount of the note and the cash necessary to repay that note is reported as interest expense. The journal entry follows:

Assume that $100,000 is borrowed for 12 months at 8% interest.

The annual interest is $8,000, but, if the interest attribution method is based on the "rule of 78s," it is assumed that 12/78 of the total interest is attributable to the rst month, 11/78 to the next, and so forth. If the borrower desired to prepay the loan after just two months, that borrower would be very disappointed to learn that 23/78 (12 + 11 = 23) of the total interest was due (23/78 X $8,000 = $2,359). If the interest had been based simply on 2 of 12 months, the amount of interest would only be $1,333 (2/12 X $8,000 = $1,333).

discount amortization

The process of reducing a discount by recognizing interest expense

discount amortization

The process of reducing the discount by recognizing interest expense

unemployment tax

The tax imposed by Federal and state governments to financially assist unemployed workers

will appear on the balance sheet as a ___

The total amounts owed to employees for retirement benefits

defined benefit plan

With these plans the employer's promise becomes more elaborate and its cost far more uncertain. For example, a company may o er annual pension payments equal to 2% per year of service times the annual salary.

On June 1, Whit Corporation purchased a truck for $30,000. To pay for the truck, Whit issued and recorded a six-month note payable for $31,500. No other entry was recorded for the note until payment on December 1. The journal entry to record payment of the note would include

a debit to interest expense for $1,500

defined contribution plan

an agreement between a company and its employees that provides for retirement benefits

defined contribution plan

an employer promises to make a periodic contribution (usually a set percentage of the employee's salary with some matching portion also provided by the employee) into a separate pension fund account

current liabilities

are debts that are due to be paid within one year or the operating cycle, whichever is longer

income taxes

are required by federal, state (when applicable), and city (when applicable) governments to be withheld and periodically remitted by the employer to the taxing authority. In essence, employers become an agent of the government, serving to collect amounts for the government.

paychecks

are usually reduced by a variety of taxes, possibly including federal income tax, state income tax, social security taxes, and medicare/medicaid. Additional reductions can occur for insurance, retirement savings, charitable contributions, special health and child care deferrals, and other similar items.

amount withheld for federal income taxes

based upon employee earnings, frequency of pay, marital status, and the number of dependents claimed

federal insurance contributions act

commonly called Social Security/Medicare, provides retirement, financial, and medical benefits to aged, disabled, widows, and orphans.

gross pay

employees total earnings. number of hours worked multiplied by wage

warranty costs

expensed in the period of the sale

wage and tax statement

formal name for the Form W-2

The gross payroll for Zurich Corporation was $100,000. Federal income tax withheld from employee paychecks amounted to $24,000, state income tax withheld amounted to $3,000, Social Security amounted to $8,500 (both the employee and employer portion), and Medicare amounted to $3,500 (both the employee and employer portion). Furthermore, employees elected to have $1,000 of insurance and charitable contributions withheld from their paychecks. How much was net pay?

gross payroll-deductions= (100,000-24,000-3,000-8,500/2-3,500/2-1,000)= $66,000 amounts where both employee and employer portion is withheld divided by 2.

current liabilities must first be

incurred

interest calculator

interest on a $100,000, 8% loan for 180 days would be $4,000 assuming a 360-day year ($100,000 X .08 X 180/360), but only $3,945 based on the more correct 365-day year ($100,000 X .08 X 180/365)

The guidelines for recording contingent liabilities

into the accounts stipulate that the future event be probable and the amount of liability be reasonably etimable

The Discount on Notes Payable

is a contra-liability account

The discount on notes payable

is recorded as discount amortization

Employers typically finance retirement plans by...

making periodic cash payments directly into a pension fund

current liabilities section of the balance sheet contains

obligations that are due to be satis ed in the near term, and includes amounts relating to accounts payable, salaries, utilities, taxes, short-term loans, and so forth.

current liabilties are....

one year or the operating cycle, whichever is longer. for most businesses it is less than one year.

unemployment tax

payroll taxes borne exclusively by the employer

by definition, contingent liabilities are...

probable

Burgundy Drug Store paid $137,000 in salaries during 20X1. Salary expense for the year was $148,500 and salaries payable at the end of 20X1 amounted to $17,300. What was the amount of salaries payable as of January 1, 20X1

salaries expense- total salaries paid thus far (148,500-137,000)= 11,500 salaries payable amount- amount of salaries not paid or accounted for= (17,300-11,500)= $5,800

An example of an accrued liability is:

salaries payable

Collections for third parties

should be recorded as a current liability

compounding

take note agreement will address this by stating the frequency of compounding, which can occur annually, quarterly, monthly, daily, or continuously (which requires a bit of calculus to compute). The narrower the frequency, the greater the amount of total interest.

w-4

tax document containing Withholding allowances

operating cycle

the length of time it takes to turn cash back into cash. That is, a business starts with cash, buys inventory, sells goods, and eventually collects the sales proceeds in cash. The length of time it takes to do this is the

guidelines for recognition of contingent liabilities

they should be recorded in the accounts when it is probable that the future event will occur and the amount of the liability can be reasonably estimated

A Discount account should be established

when interest is included in the face amount of the note.